The emissions trading scheme is effectively a grand experiment in identifying the price of international emissions reductions. It won’t necessarily reduce emissions in Australia, but it has the capacity to do so, so what should be the bottom line in negotiations?

Now that the Liberals have effectively dealt themselves out of the game it is up to the Green and other independent Senators. The current legislation won’t necessarily reduce Australia’s emissions, but it does give the Minister, and then the Climate Change Regulatory Authority the power to do so.

There are lots of questions for the Senate inquiry on implementation issues not specified in the legislation. Two questions are fundamental. Firstly who can buy permits at auction and secondly what are the conditions on the acceptance of international units, and at what point will the Minister step in to avoid the system becoming ‘swamped’.

At present, Australia’s legislation is about fitting Australia into a global system and then letting the system sort out where emissions reductions should take place. The proposed structure for protecting emissions intensive exporters, while imperfect, is probably workable. The timetable for special assistance for coal is short enough to support investment in the best medium-term solution, a dash for gas electricity generation on Australia’s eastern sea board based on Queensland’s ample coal seam methane reserves. While no-one likes rewarding polluters, some transition arrangements are necessary, for coal power in the short-term, and for exporters until there is a global agreement to prevent carbon leakage.

What about all those well-meaning households investing in photovoltaic systems? A big concern of GetUp and others is corporate Australia free-riding on Australian households’ voluntary emissions reductions. When households reduce their carbon foot print, polluters can simply increase their emissions.

Actually, what the emissions trading scheme is trying to communicate is that photovoltaics are not a particularly economically efficient way of reducing emissions. You can now by a 1KW system for around $4000 after rebates. But that might only save 0.9-1.4 tonnes of carbon dioxide each year, because the daytime operation of solar electricity competes more with gas generation than coal. After taking into account the value of the power generated, one is effectively paying $170 for every tonne of CO2 that is offset. That is four times the early phase price cap. It might be much cheaper and effective to simply buy emissions permits from the market.

The key test is not whether a well-meaning investment in reducing household emissions has the effect of lowering overall emissions or the price, but whether households can effectively improve the emissions target by purchasing emissions themselves or through a charity. If charities are enabled to participate as bidders in the auction system then we have the potential for an efficient outcome and a significant reduction in emissions, almost irrespective of the 5% reduction target. It works like this. Currently, if the average Australian emits 25 tonnes of Carbon dioxide equivalent each year, then the power companies and petrol refineries will be required to buy 25 tonnes worth of emissions permits from the auction system. The average person can reduce their emissions by purchasing green power, which should reduce the number of permits that the power company has to buy. This may then allow those permits to be used by another emitter, resulting in no net reduction.

Alternatively the person could make a donation to a Charity that was willing and able to purchase emissions units from the trading scheme. It simply sits on these permits as a tangible contribution to saving the Great Barrier Reef, Murray-Darling Basin or other likely climate change victim. Because these permits are simply purchased and taken off the market, then the available permits for polluters falls and the price rises. If the price of permits was $10/tonne then by spending $250 a person would reduce emissions around Australia by 25 tonnes, offsetting their entire emissions without giving a polluter a free-ride.

If enough Australians felt that it was really important that we hit a 90% reduction or 85% reduction by 2020 then, assuming that non-emitters can acquire permits, it is simply a question of how much they are willing to spend.

This is highly efficient, as it should directly demonstrate the willingness to pay to reduce emissions, with the government then using the additional auction revenue to compensate other households and businesses hit by the price rises. The big question is whether the CPRS regulations will allow individuals, charities and other organisation to voluntarily up the pace of emissions reductions. If it does, than having a framework to reduce emissions is much better than no framework at all.

The international financial crisis is an interesting time to be encouraging the globalisation of the carbon market.

On the one hand, Mr Rudd and Ms Wong are concerned at the lack of international agreement, yet on the other they are willing to trade emissions with uncapped countries. This is the real zero-gain game; notional emissions reductions in developing countries allow developed countries to continue emitting. Developing countries are uncapped, so global emissions continue to grow, effectively unchecked. We become more economically efficient in our emissions, but unfortunately, efficiency won’t save the planet.

There is an open question of foreign emissions from developing countries flooding the Australian market. If it happens then there are mechanisms in the legislation to stop those emissions being tradable, but can we trust Labor to activate them? We want Indonesia and Papua New Guinea to stop destroying their forests, but do we want saving those forests to enable more coal to be burnt in Australia?

One solution would be a price floor that protected Australian investments in abatement and created a clear signal for when the rules on foreign reductions would be implemented. Another would be for the Australian government to support forest protection by buying such permits, but without these permits then becoming part of the Australian scheme and perhaps bridging the gap between 95% and 85% target ranges. An annual allocation of $500 million would be a clear expression of Australia’s bona fides and support an international agreement.

Ultimately the question comes down to how much Australians are willing to spend, not just locally, but globally, to save the planet.

Alex Wadsley
CLIMATE Change Minister Penny Wong has admitted that it is not a Ferrari, but it is probably not a soviet-era Lada either. The best car analogy might be an early MG race car. It is perhaps best in class for its time, but so dependent on the skills of the driver that you don’t know whether it will win the race or go into the ditch at the first turn.

Alex has an excellent idea for intervention in the ‘free’ market which the captains of industry laud so it will be interesting to see who is willing to buy permits because they most likely will buy in cheap emissions and then as the number of permits declines their value will rise.

As Alex points out taking out permits reduces the capacity to offsett emissions through a low price mechanism so I cannot imagine with such a ‘flaw’ in the scheme, where the price could be driven up by ‘traders’ rather then charities, would be allowed to operate.

If ‘traders’ could operate in a ‘free’ market we could see short selling and the distortions that can generate.

If you wish to think how it will operate theink stock market with brokers, brokerage fees, regulators and regulations, large parcel trading and everything else imaginable to prevent an offsett at under the ceiling price of $45 per tonne per Aussie [$1260 a year].

Posted by phill Parsons on 18/03/09 at 06:36 AM

Great analysis Alex.

I have several problems with the governments ETS that cause me to suspect the validity of the entire scheme.

1) Since the natural resources (coal, gas etc) are all sold to the miners/polluters by governments, why can’t they adjust the sale price to account for the carbon produced? Surely that sends the right signals without all the hoopla?

3) Why not provide incentives for success rather than mammoth schemes to penalise failure?

Frankly the entire scheme looks like a clutch of bureaucrats, administrators and financiers have sat down to figure out a way to increase their own importance, rake in more taxes and build bridges to big business.

Posted by Mike Bolan on 18/03/09 at 09:47 AM

Having environmental charities buying permits to prevent emissions would not be an intervention in the market, but a fulfillment of the most cherished theories of microeconomics. This is the theory that if you allocate property rights, including pollution, then the market will determine the right outcome, including how much pollution should be produced.

As for the brokers et al. They won’t necessarily drive the price up or down, but they will generate plenty of employment which will help support the economy. As for cheap emissions abroad, it would be fun to think of Macquarie Bankers travelling up the rivers of Borneo, saving the Orangutan for the sake of the mighty dollar and the Big Australian. Not such a bad outcome really.

Posted by Alex Wadsley on 18/03/09 at 01:01 PM

Hi Mike,

1) Significant increases in taxation on natural resources would constitute ‘sovereign risk’ to international investors and discourage long term investment (this is also one of the justifications for the coal industry compensation). While laymen may think that the government ‘owns’ and then ‘sells’ resources to industry, it is actually industry that creates the value of resources through the exploration and appraisal process. What the government sells is the right to risked exploration, with the governments royalty share generally proportional to the exploration risk. Highly prospective exploration areas have high government takes ... Libya, Nigeria.. low prospectivity areas have low takes ... Ireland. Australia is somewhere in the middle.

2) Acting to reduce emissions directly leads to government sponsored myths like ‘clean coal’, the world’s new answer to cold fusion. Government spending is too often based on political convenience and electorates than reality. By setting it to the market they avoid political bias, the profit motive is ruthlessly efficient, but beware what you wish for. Note private firms are not lining up to waste money on clean coal, they are investing in solar thermal.

3) Incentives or costs? Costs are ultimately cheaper: can you imagine the outcry if you paid BHP, Rio Tinto, Loy Yang etc to clean up their act? Plus a clear threat of higher costs creates an incentive to do something while the system is being developed. A system when you reward polluters for cleaning up creates a disincentive for early action until the government is ready to write cheques and sometimes encourages businesses to delay investments which make sense on other grounds ... leading to higher pollution(i.e. if I wait 12 months will the government pay me to replace this dodgy boiler?). Pollution taxes are ultimately efficient, while income and profit taxes are not, better to tax pollution when you can.

Posted by Alex Wadsley on 18/03/09 at 02:51 PM

Alex,

I disagree – the Wong scheme is a Soviet-era Lada - without wheels.

Does your Charity extend to purchasing emissions permits at auction every year? And if so, what do you envisage will be the impact on employment of your proposal?

The Wong political logic holds that funds raised through the auction of emissions permits will be returned to “low-income” households to help them offset the increased costs of goods and services caused by the introduction of the ETS.

Therefore, your “Save the Barrier Reef” Charity might invest $100 million in year 1 of the scheme to reduce the pool of emissions available in that year by about 10%. It would need to do this every year for at least the next 4 years, until the new emissions target was set. You have invested $500million in 5 years and likely to need much more in years 6-10 if your scheme is to hold its ground.

All of these charitable donations would end up going to the poor consumers, whose consumption is helping drive the destruction of the barrier reef in the first place. Your scheme would also likely have the effect of increasing the pool of poor consumers in need of support, as more of them would have lost their jobs as a result of your charitable activities forcing the price of emissions permits higher than they need be (due to increased scarcity of permits to trade within the system).

This seems very odd indeed.

I would prefer first to see more analysis of the potential for re-jigging the tax system. Companies that make big inroads into emissions reductions should be rewarded with reductions in employment-related taxes first (and perhaps even reductions in profits tax), before surplus proceeds from permit auctions are redistributed. This would stimulate higher employment in sectors that can most quickly reduce emissions, and offset employment loss in other sectors finding it more difficult to reduce emissions. There is no loss of tax revenue to the government, providing the Federal and State tax departments can agree to the swap.

Consumers would have to bear more of the load of higher prices under this scheme, but this may be a better target for your charity - supporting the acquisition of energy saving devices for households. But that takes us back to where you started.

Let’s at least try to put the wheels onto the Lada before setting off on this journey. I will continue to argue for the immediate start of a pilot study of the proposed ETS in Tasmania.

Tasmania’s economic diversity and its separation from the Australian economy make it an ideal location for an economic trial of this nature. If we hit troubles, Tassie can be buffered by the wider Australian economy. We could examine Turnbull’s ideas for incorporating land-use into the scheme and the emerging problems with National competition policy (eg can Hydro Tas give cheap low-emissions power to State-based industry?). Within months, we could discover much of what needs to be discovered to give Australia confidence in whatever scheme is finally agreed to be introduced.

Confidence will provide momentum. And as we have seen in the global financial economy recently, without momentum, nothing will happen.

Ben Quin

Posted by Ben Quin on 18/03/09 at 07:12 PM

OK thanks Alex.

How about “THE Rudd Government’s environmental credentials are in tatters: the Carbon Pollution Reduction Scheme has been exposed as a sham. This shouldn’t be surprising. There isn’t one cap-and-trade scheme in the world that has resulted in a reduction in carbon emissions. Instead, such schemes have made money for the biggest polluters and created a new branch of the derivatives industry that creates new wealth opportunities for brokers and financiers.

“Rudd’s cap and trade scheme benefits the worst polluters.” from Kenneth Davidson of The Age today.

On my 2) I still cannot see why governments cannot act to reduce emissions e.g. through public transport systems, purchasing policy, incentives for renewable use etc. The ETS still looks to me like a bureaucratic fiscal fantasy for self aggrandisement and KD’s article only reinforces that impression.

On 3) Surely governments can offer a substantial ‘prize’ for effective emissions reductions, costing less, only paying on success and without all the bureaucratic hoopla?

Also why is all this represented as a cost? Why isn’t it an investment in a more stable future? We didn’t bitch about the ‘cost’ of creating jet aircraft, or the ‘cost’ of opening up global markets. If the government cannot see that this is an opportunity to take better control of our future, perhaps that’s the problem?

I can’t help but suspect that official thinking on all of this is deeply dysfunctional.

Posted by Mike Bolan on 19/03/09 at 08:23 AM

It could well be that addressing climate change and associated problems of overpopulation and environmental collapse are simply way beyond humanity’s collective capacities for altruistic discipline. If that is the case, we might as well continue with the present policy of accelerated deck chair rearrangement.

John Hayward

Posted by john hayward on 19/03/09 at 09:29 AM

There is no question that a carbon tax would be easier and more effective in reducing Australian carbon emissions than the current scheme. You can find my position on this in the TT archives (e.g A Workable Carbon Solution:

However for such a system not to result in rising emissions elsewhere through carbon leakage it would require full compensation of exporters. This is effectively the carbon consumption tax proposed by Geoff Carmody, which would be less of a burden on polluters than what is currently proposed. The differences between what is proposed and a carbon tax are at this point are marginal.

The question raised by Ben Quin as to whether Charities will have to buy a permit each year is a crucial one. Would Penny Wong use purchases of permits by Environmental Charities as an excuse to keep the cap high, or use it to justify driving the cap lower. Ultimately this is a question of who pays and how much, but it would be appropriate for the government to set a clear guideline as to whether charitable purchases would be matched by reduction in the cap in the following cap period. This would be a good way for the environmental charity market to inform public policy.

I’m concerned with Ben’s idea that compensating low income households is a bad thing. The whole objective of the ETS is not to make people worse off, but to change relative prices keeping households as whole as possible. The change in relative prices encourages purchases of environmentally friendly products over bad ones. It is attempting to make the Adam Smith’s invisble hand work in favour of the environment rather than against it. Obviously this is hard for some folks to accept, but that’s because the hand is invisble. Note the title of my article.

An experiment in Tassie should focus on becoming Carbon neutral, with the associated tourism kudos. It seems fairly pointless from an Australian ETS perspective because the elephant is moving Australia’s power sector away from coal, and Tassie’s role is but a fly on its behind.

People who are genuinely concerned about climate change better wake up and smell the coffee pretty fast. Further debate about mechanisms is an argument for delay, dithering and John Howard’s perfectly executed campaign of obfuscation. Much of Labour is clearly ambivalent, with the Senate ETS vote playing the role of the Republic referendum that to quote Turnbull ‘broke Australia’s heart’.

There is no indication that if the Senate voted down the ETS that any Australian government would try anything again ... ever, let alone a carbon tax during a recession.

The decision is whether we accept a mechanism, however imperfect, that gives businesses the real signal to invest in climate change, or whether we dither for another decade.

The jobs argument against emissions trading is quite simply a lie. Passing of the ETS bill will signal the end of the recession in Australia.

“The ETS Jobs Bonanza”.. coming up next..

Posted by Alex Wadsley on 19/03/09 at 12:53 PM

Well done Alex. That was a rocky road for awhile there.

Hot topic, hot responses.

Posted by Mike Bolan on 19/03/09 at 04:41 PM

Alex,

Some parts of the argument you present in your last post appear to be contradictory.

On the one hand you harangue us with “Further debate about mechanisms is an argument for delay,—-” . On the other hand, you admit that the central tenant of your original post – that charities should be allowed to purchase tradeable emissions permits – is a matter about the mechanics of the ETS that requires further debate. Are you standing in as a double agent for John Howard here? I would also be interested in your opinion on what this meeting in Copenhagen is about later this year. I may have missed something on that agenda.

I also consider your reference to Adam Smith’s “Invisible Hand” to be incorrect in the context of your argument. The use of ETS funds by Government to subsidise household consumption is anomalous with Mr. Smith’s observations on the workings of free markets, if the objective is to reduce emissions. He has advised me that he prefers my idea of reducing employment-related taxes first.

Whilst I consider the proposed ETS to be flawed, I am in strong support of the need for immediate action. We must maintain a national momentum for change. My fear is that Rudd and Wong will backslide on the grease provided by the current financial crisis.

Your dismissal of my proposal to immediately commence a pilot trial of the proposed ETS in Tasmania with the “fly on the elephant’s bottom” analogy misses the point of my proposal. I also note that you use exactly the argument that the obfuscators use about Australia’s contribution to the global emissions pool.

The Tasmanian trial will provide momentum for the ETS. The key hurdle we need to jump in building national consensus for the introduction of the ETS is uncertainty. This uncertainty is driven in large part by fear of negative employment impacts and administrative difficulties associated with implementing the scheme. I don’t propose the Tasmanian pilot to cause delay, nor to develop technology for reducing emissions elsewhere. Rather, I propose the trial as a means of overcoming uncertainty, avoiding unforseen administrative problems in the design of the scheme and for suggesting ways that the existing scheme could be improved. It may also pop out some juicy technical ideas worthy of early pursuit – the role of water in the carbon economy for example.

We have 8 precious months ahead of the Copenhagen meeting. Australia could learn much to improve its negotiating position and influence world opinion at Copenhagen if it had data from a real-time, real world trial of its proposed ETS. Perhaps Alex, you next article on the ETS Jobs Bonanza would benefit from some real-world observation of the ETS too?

By the way, my Mum, a good horsewoman, always warned me that a bot-fly on a horse’s bum could cause it to bolt. I don’t know if she had any experience with elephants.

Ben Quin

Posted by Ben Quin on 19/03/09 at 07:32 PM

Re Ben: Post Scriptum Notes:

The ability of Charities to acquire permits is a matter for the regulations, rather than a change to the legislative mechanism. It should be explored as part of the Senate committee process but doesn’t necessitate a change in the legislation, the same goes for how such acquisitions are treated in determining the capacity of the economy to reach more stringent emissions targets in future periods.

Whether recycling of revenue happens through handouts to households or tax adjustments is similarly a secondary detail with respect to the legislation at hand. All that is important is that the revenue is handed back and is not a net tax.

I’m happy to have a trial in Tasmania of an ETS or any other climate response policy, as long as it doesn’t backslide or delay getting a national framework passed into law that allows major investment in gas pipelines and other necessary adjustment infrastructure to be accelerated. A six-month pre-start in Tasmania could allow some useful administrative lessons to be learned, but given the fundamental differences between Tasmania’s energy sector and the rest of Australia there would only be limited information provided on the least cost adjustment path. A trial on integration of agriculture and forestry into the ETS could be successfully undertaken in Tasmania.

Posted by Alex Wadsley on 20/03/09 at 12:51 PM

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